Nothing strikes fear in the hearts of investors more quickly than the word “recession.” And with that dreaded word seemingly popping up everywhere in recent days and weeks, it may be a good time to look to history to see whether the panic is warranted.
The classic definition of a recession is two consecutive quarters of declining real gross domestic product (GDP). However, the most widely adapted definition is from the National Bureau of Economic Research (NBER), which states a recession “is a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”
While the definition leaves room for interpretation, since 1950, all but two of the recessions identified by NBER (1960 and 2001) were accompanied by two or more consecutive declining quarters of real GDP (the other two contractions had two quarters of declining GDP that were not consecutive), demonstrating there is significant overlap between the two methodologies. Regardless of which criteria is used, it is safe to say a recession is an event that coincides with a significant downturn in the economy.
Recessions tend to be short-lived
There have been 11 recessions since 1950, with the typical economic contraction lasting an average of approximately 10 months. This means that historically we have seen a recession roughly every 6.5 years. While the economic downturn may feel long for those living through it, the pain is relatively short when compared to the expansion that typically has followed. As you can see based on the data in the chart, during the past 72 years, post-recession expansions have lasted an average of 65 months.
Economic Expansions and Contractions
While recessions are unpleasant from an economic standpoint, they don’t necessarily warrant the dread investors often feel. The average return of the S&P 500 during recessions since 1950 is -6 percent, with the worst being a 27.2 percent loss during the recession in 2007. In fact, this was the only recession that saw a loss of 20 percent or more during its duration, and almost half of recessions saw positive stock returns during their time span. To be fair, markets have often seen negative returns in the weeks and months leading up to the recognized start of a recession.
Additionally, stock market performance coming out of recessions tends to be strong. Forward cumulative one- and two-year returns following a recession have averaged almost 20 percent and 30 percent, respectively. These historical rebounds highlight the importance of staying invested to avoid missing the potential for above-average returns that tend to follow recessions.
How the stock market behaves
The economy and the stock market take turns leading and following in a complicated dance that moves our financial world. It may seem surprising, but the stock market often peaks before the official start of a recession. In fact, since 1950, in all but three instances the stock market peaked before the beginning of a recession, with the average time being six months prior to the start. Odds are, if there is an economic downturn on the horizon, the stock market has already peaked and begun to sell off in anticipation of the event.
It is reasonable to wonder: If the stock market peaks prior to a recession, does it bottom before the end of it? On average, the answer is yes. When analyzing the last 11 recessions, the average length of time for the stock market to bottom after the start of a recession was about six and a half months. It took 15 months during the Great Recession (2007) for the markets to bottom. This was an anomaly; the Great Recession was called “great” for a reason — significant debt levels led to an almost unthinkable collapse of both consumers’ finances and the banking system. Notwithstanding this event that remains fresh in the minds of many investors, 45 percent of all recessions that have occurred since 1950 saw the stock market bottom within four months after the contraction began.
The last two recessions produced the longest as well as the shortest time for the market to bottom since 1950. Because these recent economic contractions were unusual, we believe it’s worth looking at a longer period of history to frame our expectations for the impact a recession may have.
You don’t know until you know
One of the challenges of navigating recessions is that no one knows they are in one until they are told. Further, NBER does not inform in real time when a recession starts. Since NBER started formally recognizing recessions in 1980, the average lag between the start of a recession and the formal announcement was almost eight months. The lag is even greater — 16 months — for the NBER to acknowledge the end of a recession. The delay in calling the beginning or end of a recession is rooted in NBER’s need for certainty in the accuracy of the data used to gauge economic activity. However, the lag can have real-world investment implications.
Given that the average lag between the start of a recession and the announcement of a recession is eight months, and the average length of time for the stock market to bottom during a recession is 6.6 months, it makes sense to consider that the formal announcement of a recession could be viewed as a turning point for the markets. Looking back at the past six recessions since 1980, the S&P 500 has posted an average return of 13.7 percent during the period between the official recognition of the start of a recession and the end of the slowdown. Additionally, the S&P 500 posted negative returns only once during those six periods. For perspective, the average annualized return for the S&P 500 since 1980 was 8.7 percent. This is not to imply that this is a trading strategy but to highlight that successful investing often requires looking forward. By the time a recession is announced, it is possible that the worst may be over.
Staying the course
Whether we enter a recession today, tomorrow or in the future, having a plan in place can help guide you through turbulent times in the market and help you stay the course. Focus on your long-term goals instead of getting distracted by the short-term noise in the stock market. The fact is, wealth isn’t generated only when times are good but also by the decisions you make when the markets are under pressure. When others feel the need to react and grasp for short-term gains from one day to the next, we’re able to tune out the noise. Our ability to remain steadfast and use it as an opportunity for growth, helping capture the upside when the markets eventually recover, comes from our longstanding commitment to drive value over time — because we’ve seen that playing the long game tends to win, generation after generation.
Commentary is written to give you an overview of recent market and economic conditions, but it is only our opinion at a point in time and shouldn’t be used as a source to make investment decisions or to try to predict future market performance. To learn more, click here.
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